The US Commodity Futures Trading Commission (CFTC) recently published (and requested comment on) two proposed orders that would exempt certain energyrelated transactions from many of the requirements of the Commodity Exchange Act (CEA) and its accompanying regulations. The first proposed order (the Not-For- Profit Proposed Order)1 would exempt non-financial energy derivative transactions between government-owned electric utilities and/or cooperatively-owned electric utilities when such transactions are: (i) intended to be physically settled; and (ii) entered into for the primary purpose of meeting contractual obligations to facilitate the actual generation, transmission, or delivery of electricity. The second proposed order (the RTO/ISO Proposed Order)2 would exempt four types of transactions when they are offered or sold in a market administered by certain Regional Transmission Organizations (RTOs) and Independent System Operators (ISOs) (collectively, the Requesting RTOs and ISOs) pursuant to a tariff or protocol that has been approved by the Federal Energy Regulatory Commission (FERC) or, as applicable, the Public Utility Commission of Texas (PUCT). The four types of transactions that would be exempt under the RTO/ISO Proposed Order are:
- Financial Transmission Rights
- Energy Transactions
- Forward Capacity Transactions
- Reserve or Regulation Transactions
The exemption under the RTO/ISO Proposed Order would only extend to “appropriate persons,” as defined in Section 4(c)(3)(A) through (J) of the CEA or “eligible contract participants,” as defined in Section 1a(18) of the CEA and CFTC regulations. The exemptions in the RTO/ISO Proposed Order are also contingent upon the CFTC entering into satisfactory information sharing arrangements with the FERC and, if applicable, the PUCT.
Under both the Not-For-Profit Proposed Order and the RTO/ISO Proposed Order, the CFTC would retain its general anti-fraud, anti-manipulation, and enforcement authority under the CEA. The CFTC encourages comments from stakeholders affected by these proposed orders; comment periods for these proposed orders close on September 24, 2012 for the Not-For-Profit Proposed Order and September 27, 2012 for the RTO/ISO Proposed Order.
Once these orders become final, they will exempt applicable utilities and many other electric market participants entering into financial transactions relating to energy generation and transmission without the need to file for additional relief from the CFTC.
The Not-For-Profit Proposed Order
Although Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank)3 significantly amended the CEA to expand the scope of the CFTC’s jurisdiction to cover swaps, Congress also included a savings clause in Dodd-Frank that builds upon the CFTC’s general exemptive authority and allows the CFTC to exempt from the requirements of the CEA transactions that are entered into between certain not-for-profit entities identified in the Federal Power Act (FPA).4 Relying on this provision, a group of trade associations representing government and cooperatively-owned electric utilities submitted a petition for exemptive relief to the CFTC on June 8, 2012. The petition claimed that certain energy derivative transactions between certain not-for-profit entities should be exempt from the requirements of the CEA because, among other reasons, the notfor- profit entities merely use the derivative transactions to hedge commercial price risk arising from their electric facilities and ongoing electricity operations (i.e., and not to profit from speculating or dealing in such agreements).
- Scope of the Not-For Profit Proposed Order
The Not-For-Profit Proposed Order would grant most of the relief sought in the petition. The Not-For-Profit Proposed Order does, however, contain important limitations with regard to the types of transactions and types of entities subject to the exemption.
- Entities Subject to the Exemption
The Not-for-Profit Proposed Order identifies 4 categories of “Exempt Entities”:
- Government-owned electric utilities described by Section 201(f) of the FPA5
- Electric utilities owned by Federally-recognized Indian tribes, otherwise subject to regulation as public utilities under the FPA
- Cooperatively-owned electric utilities, regardless of whether such utilities are described by FPA section 201(f), so long as they are treated as cooperative organizations under the Internal Revenue Code and exist for the primary purpose of providing electric energy service to its member/owner customers at the lowest cost possible
- Any not-for-profit entity that is wholly owned, directly or indirectly, by any one or more of the foregoing6
The Not-For-Profit Proposed Order further provides, however, that “Exempt Entities” do not include any “financial entity,” as defined in Section 2(h)(7)(C) of the CEA.7
- Transactions Subject to the Exemption
In addition to the limitations on eligible entities, the Not-For-Profit Proposed Order would exempt only “Exempt Non-Financial Energy Transactions.” Exempt Non- Financial Energy Transactions are transactions that are: (i) based upon a commodity (as defined by the CEA) where (ii) the primary purpose of the transaction is to satisfy existing or anticipated contractual obligations to facilitate the generation, transmission, and/or delivery of electric energy service to customers at the lowest cost possible and (iii) the transaction is intended for making or taking physical delivery of the commodity upon which the transaction is based. More specifically, the Not-For-Profit Proposed Order would limit the exemption to the following categories of transactions:
- Electric Energy Delivered transactions consisting of arrangements in which a provider Exempt Entity agrees to deliver a specified amount of electric energy to a recipient Exempt Entity within a defined geographic service territory, load, or electric system over the course of an agreed period of time.
- Generation Capacity transactions where a recipient purchases the right to call upon a specified amount of the seller’s electric energy generation assets to supply electric energy within a defined geographic area, regardless of whether such right is ever exercised for the purposes of the recipient meeting its location specific reliability obligations.
- Transmission Services transactions consisting of arrangements in which a provider owning transmission lines sells the right to deliver a specified amount of electric energy to a recipient from one designated point on the transmission lines to another, at a set price per wattage and over a certain time period, in order for the recipient to provide electric energy to its customers.
- Fuel Delivered transactions consisting of arrangements used to buy, sell, transport, deliver, or store fuel used in the generation of electric energy.
- Cross-Commodity Pricing transactions consisting of arrangements such as heat rate transactions and tolling agreements in which the price of electric energy delivered is based upon the price of the fuel source used to generate the electric energy.
- Other Goods and Services transactions consisting of arrangements in which the parties enter into an agreement to share the costs and economic benefits related to construction, operation, and maintenance of facilities for the purposes of generation, transmission, and delivery of electric energy to customers.
Exempt Non-Financial Energy Transactions may exist as stand-alone agreements or components of larger agreements. Expressly excluded from the definition of Exempt Non-Financial Energy Transaction, however, are transactions derived from any interest rate, credit, equity or currency asset class, or any grade of a metal, agricultural product, crude oil or gasoline that is not used as fuel for electric energy generation.8
The CFTC also noted that it would not include environmental rights contracts, allowances or attributes within the definition of “Exempt Non-Financial Energy Transactions.” These types of contracts relate to a wide variety of federal, regional, state, and local environmental rights, allowances, or attributes required to operate a particular not-for-profit electric entity’s facilities or operations. The CFTC explained that these arrangements are nonetheless exempt from many requirements of the CEA because they would be covered under by the forward exclusion from the swap definition.
Notwithstanding the proposed relief in the Not-For-Profit Proposed Order, the CFTC would retain its general anti-fraud, anti-manipulation, and enforcement authority under the CEA and CFTC regulations. Finally, the CFTC would reserve its authority to inspect the books and records kept in the normal course of business that relate to Exempt Non-Financial Energy Transactions between Exempt Entities pursuant to the CFTC’s regulatory inspection authorities.
The RTO/ISO Proposed Order
In addition to the savings clause related to the entities identified in Section 201(f) of the FPA, Congress included in Dodd-Frank a provision addressing the role of the CFTC vis-à-vis the FERC and the State agencies that regulate electricityrelated transactions traded pursuant to the tariff of an RTO or ISO. Specifically, Section 722(e) of Dodd-Frank provides that nothing in Dodd-Frank shall limit the authority of FERC or a State regulatory authority with respect to an agreement, contract, or transaction that is entered pursuant to a tariff or rate schedule approved by FERC or a State regulatory authority and is executed, traded, or cleared on a registered entity or trading facility owned or operated by an RTO or ISO. Section 722(f) of Dodd-Frank also added Section 4(c)(6) to the CEA, which provides that the CFTC shall exempt from the requirements of the CEA an agreement, contract, or transaction that is entered into pursuant to a tariff or rate schedule approved or permitted to take effect by FERC or a State regulatory authority if the CFTC determines that such exemption would be consistent with the public interest and purposes of the CEA.
Pursuant to these provisions, the Requesting RTOs and ISOs submitted a consolidated application for exemption on February 7, 2012 requesting that the CFTC exempt four classes of contracts from all provisions of the CEA and CFTC rules (other than those sections prohibiting fraud or manipulation). In support of the application, the Requesting RTOs and ISOs claimed that an exemption is in the public interest, and thus appropriate because, among other reasons, the Requesting RTOs and ISOs and the relevant transactions are already subject to comprehensive regulation from the FERC and pursuant to their tariffs and protocols.
- Scope of the RTO/ISO Proposed Order
As with the Not-For-Profit Proposed Order, the RTO/ISO Proposed Order would grant most of the relief sought by the Requesting RTOs and ISOs but contains important limitations with regard to the types of transactions and types of entities subject to the exemption. The RTO/ISO Proposed Order also proposes to condition the exemption on certain events.
- Transactions Subject To the Exemption
The RTO/ISO Proposed Order identifies only the following types of transactions as exempt transactions:
- Financial Transmission Rights — Financial Transmission Rights (FTRs) are transactions that entitle one party to receive, and obligates another party to pay, an amount based solely on the difference between the price for electricity at a specified source (i.e., where electricity is deemed injected into the grid) and at a specified sink (i.e., where electricity is deemed withdrawn from the grid). The RTO/ISO Proposed Order would only apply to those FTRs that satisfy the following conditions:
- Each FTR is linked to, and the aggregate volume of FTRs for any period of time is limited by, the physical capability (after accounting for counterflow) of the electricity transmission system operated by the Requesting RTO or ISO offering the contract for such period.
- A Requesting RTO or ISO serves as the market administrator for the market on which the FTR is transacted.
- Each party to the transaction is a member of the Requesting RTO or ISO, or is the Requesting RTO or ISO itself, and the transaction is executed on a market administered by the Requesting RTO or ISO.
- The transaction does not require any party to make or take physical delivery of electricity.
- Energy Transactions — Energy Transactions are transactions in the day-ahead market or real-time market for the purchase or sale of a specified quantity of electricity at a specified location where the price of electricity is established at the time the transaction is executed.
Forward Capacity Transactions — Forward Capacity Transactions fall into three separate categories:
- Generation Capacity Contract — General Capacity refers to the right of a Requesting RTO or ISO to require certain sellers to maintain the interconnection of electric generation facilities to physical locations in the electric power transmission system during a future time period. General Capacity contracts also requires a seller, subject to applicable tariff provisions, to interject electric energy into the electric power transmission system operated by the Requesting RTO or ISO.
- Demand Response Rights — A Demand Response Right provides a Requesting RTO or ISO the right to require that certain sellers of such rights curtail their consumption of electricity curtail their consumption of electricity from the Requesting RTO or ISO electricity transmission system during a future period of time.
- Energy Efficiency Rights — Energy Efficiency Rights provide the Requesting RTO or ISO with the right to require specific performance of an action on the part of the other party that will reduce the need for General Capacity or Demand Response Rights over the duration of a future period of time.
- Reserve or Regulation Transactions — Reserve Regulation Transactions allow a Requesting RTO or ITO to purchase through auction the right to require the seller to operate electric facilities in a physical state such that the facilities can increase or decrease the rate of injection or withdrawal of electricity to the electric power transmission system operated by the Requesting RTO or ISO with physical performance by the seller’s facilities within a response interval specified in the Requesting RTO or ISO’s tariff, or prompt physical performance by the seller’s facilities.
No transactions apart from those specifically identified would be exempt under the RTO/ISO Proposed Order. To be sure, the CFTC specifically declined to exempt “the purchase and sale of a product or service that is directly related to, and a logical outgrowth of, any [of the Requesting Petitioner’s] core functions as an ISO/ RTO . . . .” Moreover, the CFTC noted that convergence and virtual bids and transactions would not be exempt unless such transactions fall within the scope of one of the 4 specifically enumerated transactions.
- Entities Subject to the Exemption
As mentioned above, the RTO/ISO Proposed Order would not apply to all market participants. Instead, all parties to the transaction are required to be “appropriate persons,” as defined in Sections 4(c)(3)(A) through (J) of the CEA or “eligible contract participants,” as defined in section 1a(18)(A) of the CEA and in CFTC regulation 1.3(m). The term “appropriate persons,” includes, among other entities, a bank, a registered investment company, an organization with a net worth exceeding $1 million or total assets exceeding $5 million, a registered broker-dealer, or a futures commission merchant. “Eligible contract participant” is similarly defined and includes, among other entities, financial institutions, investment companies, corporations with more than $10 million in total assets, and certain commodity pools.
- Conditions to the Exemption
Like the Not-For-Profit Proposed Order, the CFTC would retain its general antifraud, anti-manipulation and enforcement authority over contracts subject to the RTO/ISO Proposed Order. In addition, the exemptions in the RTO/ISO Proposed Order are contingent upon the existence of information sharing arrangements between the CFTC and FERC, and among the CFTC and PUCT. Finally, the RTO/ ISO Proposed Order would require that neither the tariffs nor any other governing documents of a particular RTO or ISO include any requirement that the RTO or ISO notify its members prior to providing information to the CFTC in response to a subpoena or other requests for information or documentation.
We will continue to monitor the Not-For-Profit Proposed Order and the RTO/ISO Proposed Order and will provide our clients with periodic updates of noteworthy developments in this area. If you need further information regarding either order, please contact one of the attorneys listed at the bottom of this Client Alert or the Latham attorney with whom you normally consult and we will be happy to assist.